Wednesday, August 6, 2014

Based in Jacksonville, Florida, CSX Corporation (CSX) has roots dating back to the early nineteenth century – starting in 1827 when the nation’s first common carrier was chartered between the Baltimore and Ohio Railroad Company. Today 30,000 plus employees are responsible for 21,000 route miles in 23 states with access to over 70 ocean, river and lake port terminals. Railroads remain as the low cost transportation option where no waterway connects the origin and destination of shipments.
As such, you might imagine that as economies grow, requiring more shipping both domestically and internationally, the need for CSX is substantiated. In fact, CSX has not only been sustaining itself but more readily growing.

For instance, as described by Morningstar analyst Keith Schoonmaker, here’s how that message looks in words:

“CSX's competitive advantages are inseparable from the geography of its track. Its Eastern U.S. network stretches a bit farther in latitude than that of competitor Norfolk Southern, reaching into Florida and New England. The location of all its assets enables CSX to attract a diverse mix of commodities. CSX made meteoric progress in its operations during the past decade, improving safety, shortening terminal dwell time, and increasing on-time arrivals. In almost every measure of operating performance, CSX moved the needle significantly.”

It is true that the company had one down year, yet it seems the “impossible to replicate” assets and “nearly impenetrable barrier to entry” helps not only protect but also drive CSX’s profits – which grew by over 17% per annum since the end of 2004. As such, an investor would have seen returns of over 18% per year during this time.

Ordinarily we might dig a bit deeper into this side of the analysis by looking at the price and earnings correlation, why the performance results came out as they did along with the estimated returns looking forward. However, for this article we would like to focus on some of the fundamental underlying numbers, or “FUN,” aspects of this company as well. In doing so, we will see one of the most important concepts in reviewing a company: the total business results and the per share results are not necessarily the same thing.

A case in point comes in the way of looking at common equity (ce) or book value. Below we see that from the end of 2005 until 2013 CSX was able to grow total common equity from about $8 billion to $10.5 billion in 2013 – a compound rate of about 3.5%. However, notice that in 4 of the 8 years there was a decrease in book value and generally the growth wasn’t very consistent.

Conversely, when we view the common equity per share (ceps) figures below, we see a much more consistent and positive rate of growth. Per share book value jumped from about $6 a share to over $10 a share for a compound rate of about 6.5%. Moreover, there were just 2 negative years, and even then the book value only decreased by 1% annually.

So what’s the underlying cause of this discrepancy? Quite simply, CSX began an effective share repurchase program. Below we can see that common shares outstanding (csho) went from about 1.3 billion at the end of 2005 to just over 1 billion by 2013 – a 3% yearly reduction. Said differently, the reason why per share book value was largely consistent and growing was due to a solid buyback plan.

Perhaps just as interesting is the idea that this has only been the case as of late. If we look further back in history – back to 1994 for instance – we see that common shares outstanding actually increased in some years and remained in the 1.25 to 1.3 billion share range for a long time. So in the future this might be something to monitor: will CSX continue its strong repurchase program or will share count remain constant? If it’s the former an investor (possible given that CSX is presently in the middle of a $1 billion share repurchase program) might see per share growth outstrip total company growth in all metrics.

Beyond repurchasing shares, paying a dividend is likely the most well-known way to return cash to shareholders. To this point CSX has shown a strong propensity to do so by not only paying but also increasing its dividend for the last 10 consecutive years. With shares currently yielding about 2.1%, it’s prudent to include this expected cash flow in your expected return assumptions. So if you’re going to count on this cash component, you might want to check in on its sustainability.

Below we have included a per share graph dating back to the end of 2005. Here we see cash flow per share (cflps) as the top light blue line along with capital expenditures per share (capxps) and dividends paid per share (dvpps). Note that cash flow and capital expenditures are somewhat inconsistent while dividends are much more reliable. Additionally, notice that cash flow was able to cover the combination of the capital expenditure and dividend obligations in every year. Moving forward, you might note that the dividend is well-covered but there could be a reason that the payout ratio remains somewhat subdued: railroads require large capital expenditures, a nuisance with regard to payouts and yet a blessing in respect a competitive advantage.

Thus, the cash flows of the business should be continuously monitored. In addition to the sustainability of a business’s obligations, you might also be interested in the returns generated on behalf of your capital. Below we see a depiction of CSX’s return on equity (roe) and return on invested capital (roic) over the past 8 years. Notice that both have been increasing slightly – with ROE hovering around 20% and ROIC at about 11%.

This concept follows through with the company’s margins. Again, note the steady improvement as time has gone on. Gross profit margin (gpm) has increased from about 30% in 2006 to about 38% last year. Likewise, net profit margin (npm) has improved moving from under 14% to over 15%.

These metrics – increasing returns and improved margins – are even more impressive when coupled with growing sales. As indicated below, sales have been largely consistent since 2004 with just 1 down year in the last 10 years. It is true that the growth isn’t that impressive, but this is precisely why CSX has been a solid investment over the last decade. Improved margins, better returns, dividends and share buybacks do wonders for a company that barely grew total revenue.

Although we were primarily focused on taking a “FUN” or fundamental look at CSX, it can also be useful to look at where the shares are presently trading and what the future prospects could look like. Here we see that CSX is presently trading at just under 17 times earnings. Collectively, analysts reporting to S&P Capital IQ come to a median long-term growth estimate of about 9%. If you add in the dividend – and assume an ending P/E of 15 – this might indicate a 10.1% annual return assuming the estimated earnings come to fruition.

Overall we found CSX to be a solid company at a reasonable valuation that has been improving as of late. Due to this improvement, it might be the case that future enhancements would be subdued. After-all, it’s hard to grow margins perpetually, for instance. Thus, on a forward looking basis you might expect returns to stabilize and even bake in a bit of caution. In addition, we find that it’s useful to view not just the ordinary metrics but also a variety of additional fundamental data points. For example, looking at the dividend yield is okay. Looking at the payout ratio is good. Yet looking at cash flows and other requirements in comparison to what is being paid out is even better. And of course, you can go much further than we did in this article. Per usual, we encourage the reader to conduct his or her own thorough due diligence.
Disclosure: No position at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.